Case #35
Deluxe Corporation
Synopsis and Objectives
In July 2002, an investment banker advising Deluxe Corporation must prepare recommendations for the company’s board of directors regarding the firm’s financial policy. Some special considerations are the mix of debt and equity, maintenance of financial flexibility, and the preservation of an investment-grade bond rating. Complicating the assessment are low growth and technological obsolescence in the firm’s core business. The purpose is to recommend an appropriate financial policy for the firm and, in support of that recommendation, to show the impact on the firm’s cost of capital, financial flexibility (i.e., unused debt capacity), bond rating, and other considerations.
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4. Using Hudson Bancorp’s estimates of the costs of debt and equity in case Exhibit 8, which rating category has the lowest overall cost of funds? Do you agree with Hudson Bancorp’s view that equity investors are indifferent to the increases in financial risk across the investment-grade debt categories? 5. Is Deluxe’s current debt level appropriate? Why or why not? 6. What should Singh recommend regarding: * the target bond rating * the level of flexibility or reserves * the mix of debt and equity * any other issues you believe should be brought to the attention of the CEO and the board
Epilogue
On August 5, 2002, Deluxe Corporation announced plans to raise its debt level to $700 million. During a subsequent conference call with analysts, Deluxe Corporation’s chief financial officer (CFO), Douglas Treff, said:
We … believe Deluxe is underleveraged. We believe our steady cash flows put us in a position to increase our debt level up to $700 million and still maintain a strong investment-grade rating. The use of debt will lower our overall cost of capital and as a result increase returns on capital invested. We expect that the debt will be a combination of both long- and short-term borrowings.
The company also announced a plan to repurchase up to 20% of Deluxe Corporation’s stock, or 12 million shares. “At current prices, we believe the repurchase of
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (Eds.). (2011). Essentials of corporate finance (7th ed., Rev.). New York, NY: McGraw-Hill Irwin.
Having a conservative debt policy increased the credit worthiness of the firm. Because the firm believes that the interest coverage ratio is a critical factor for credit rating agencies, they attempted to keep this ratio very high. Also, by having a higher credit rating they are able to access short term commercial paper borrowings at better rates. This type of short term borrowing makes up 47% of Diageo’s portfolio. By not having a strong credit rating they would not be able to lock in the low rates which would impact their business significantly.
The repurchase program increases the shareholder’s value. This is because of a rise in the price of the shares of the original shareholders.
This course applies corporate finance concepts to make management decisions. Students learn methods to evaluate financial alternatives and create financial plans. Other topics include cash flows, business valuation, working capital, capital budgets, and long-term financing.
If HCA chooses to remain at the current debt ratio take on a lower rating, suspicion might arise among investors. In both cases opportunities exist as well as consequences. The advantages and disadvantages are outlined in Scenario 1 - 3.
Repurchasing shares with a 40% debt to total capital ratio would increase shareholder value, however repurchasing shares with an 80% debt to total capital ratio would significantly decrease shareholder value and therefore would not be advisable. Increasing debt increases shareholder value to a certain point. As this proforma shows, the point of diminishing return is somewhere between 40% and 80%.
Managing debt levels to maintain an investment grade credit rating as well as operate with an efficient capital structure for its growth plans and industry
5. This is the mirror question of 6. Looking at it from perspective of the client, is it advisable to pump more debt in company that is short on cash (for reasons that we need to find out).
Wendy Beaumont, the company’s president is looking to further expand and has asked the advice of friend and financial consultant, Amy McConville to review a potential acquisition or partnership. The prospects will elevate some of the president’s concerns for financing. In her own words, Ms. Beaumont expressed that the cost of financing growth right now was high and Friendly Card's projects 20% growth over the next year and even more in subsequent years. Further stating, the company had never been without financing problems and had always been capital intensive relying on strong relations with its banks and suppliers in realizing success. Still, Friendly’s bankers have begun to feel uneasy regarding the company’s heavy reliance on debt capital to finance operations. The bank reminded the company they agreed to provide financing in 1986 with the expectations of Friendly Cards’ sales would decrease substantially in the future. The firm's liabilities/equity ratio had peaked to 5.2 in 1986, and was still a couple of years away from returning to historically lower ratios. As a result, the bank strongly suggested the company obtain alternative financing to support its forthcoming peak production season.
As the Torstar board meeting in April of 1998 was approaching, a memorandum on Torstar’s dividend policy, their repurchases and their strategy with regards to strategic acquisitions within their three business areas was composed. The memorandum included pros and cons as well as recommendations with regards to the issues to be discussed when the board gathered for their meeting. The dividend policy and the share repurchase strategy are the main issues since the institutional shareholders preferred Torstar’s historical share repurchases and historical dividend pay outs. Management has during the last years focused on acquisitions, especially in order to diversify their business through the children’s supplementary education products (CSEP)
Leverage ratios are measured to identify the amount of borrowed fund used to finance firm’s operations. Leverage ratios consist of Debt-to-Asset and Debt-to-Equity ratios. In 2012, the Debt-to-Asset ratio of Inditex was 0.32 which is considered good for company’s economy as long as it is less than 0.4 (Table 2). In other words, company is not excess using debts. The Debt-to-Equity ratio for Inditex in 2012 was 0.47 which is in company’s favor as it is less than 1. This shows how leverage is well managed by the company. Comparing to rivals, Gap was scored 1.69 for Debt-to-Equity and 0.63 for Debt-to-Assets which is not in company’s favor and therefore
Pan-Europa’s ball and chain is its debt. With a debt-to-equity ratio of 125%, the company is leveraged more than its competitors. Pan-Europa’s bankers have become unwilling to provide additional credit, which is unfavorable if conditions call for the purchase of a large block of common stock to prevent a hostile takeover. As a preventative measure, Pan-Europa must bolster shareholder confidence by continuing to pay the dividend and driving up earnings, which should
the company also extended the maturity period of its post restructured debt outstanding which is
This paper focuses on a financial analysis of Chevron from the perspective of a potential creditor. The issue surrounds primarily the creditworthiness of Chevron rather than the type of credit that would be issued. Specifically, the issue is whether "we" would lend Chevron 10% of its net assets. The net assets for Chevron are $209.474 billion, so the amount in question is $20.9 billion in new debt. The report will first analyze the financial statements of Chevron in general terms, focusing on trends and ratios, and drawing conclusions about the overall financial health of the company based on that analysis. The second part of the paper will outline some of the criteria that a lending institution would have for lending to a company, and then that criteria will be applied to Chevron specifically.
To determine CCI’s retention capabilities, we looked at Dun and Bradstreet’s key business ratios using CCI’s balance sheet and income statement. In selecting retention limits for a business, it is important to look at the company’s liquidity, net worth position, income maintenance, and their total debt. The greater amount of debt that a company has the more dependent a company is on risk transfer. Dun and Bradstreet’s ratios are broken up into three different categories: solvency, efficiency, and profitability.